Payments for Pot

A Joint Solution for Illinois Innovators

The State of Illinois finds itself poised to lead innovation in two rapidly growing industries. Ss the state backs digital currency technologies and supports legalized cannabis, it stands at the nexus of federal and state jurisdiction, banking regulation, and the digital future of money and finance.

The result could be increased investment in the state’s financial technology (FinTech) startups and much-needed revenue in the state’s coffers.

Illinois expanded its medical marijuana program last year. In March, lawmakers introduced a bill that would legalize cannabis in the state outright.

The legal cannabis market is growing nicely, too. It was the biggest winner in the November general elections after President Trump, with voters in four states approving recreational use of cannabis and four more okaying medical use. The market is projected to grow at annual rates of 20% to 25% annually depending on which survey you believe.

Illinois Blockchain Initiatives

The state is making a concerted effort to bring blockchain investment and talent to Illinois. Speaking at the Chicago Blockchain Summit on October 11, the State of Illinois blockchain evangelist, Jennifer O’Rourke, noted that the state is both passionate and pragmatic in supporting blockchain opportunities through the Illinois Blockchain Initiative.

“I want to make Illinois the state of blockchain,” she said. “I want Illinois to show the way to support appropriate governance, economic development, and to integrate the technology into government itself.” In contrast to New York, which has turned companies away with its restrictive BitLicense regulations, Illinois will welcome firms while providing appropriate protections, she said.

Earlier this year, the Cook County Recorder of Deeds published the results of a trial it conducted to verify whether mortgage deeds could be verified using the public bitcoin blockchain. Although the pilot results were unsatisfactory, blockchain itself shows promise as an underlying technology of a new lands record system, according to the pilot’s final report.

“We have one of the best real estate systems in the world, but we can do it more efficiently,” said John Mirkovic, deputy recorder-communications. “Government is at a time when it needs to do things more efficiently.”

Often referred to as distributed ledger technology, “blockchain” refers to a technology that provides a cryptographically secure, unalterable ledger that can be accessed by multiple counterparties. Unlike traditional database ledgers, such as those run by banks, blockchain-based systems do not require a central party to run and manage them.

Blockchain technology is the technical innovation that solved decentralized recordkeeping, identity management, and data integrity problems for the digital currency bitcoin. In the last several years, blockchain has been heralded as a technology that will save billions in any number of industries that rely on centralized ledgers for tracking and verifying assets, including payments, capital markets, diamonds, and even music and advertising.

As part of Governor Rauner’s year-old Department of Innovation and Technology, several state agencies formed the Illinois Blockchain Initiative last November. Its purpose is “to create more efficient, integrated and trusted state services, while providing a welcoming environment for the Blockchain community.”

While the state’s efforts in establishing the council and its subsequent outreach are to be applauded, the efforts can go farther. The state could set up and support functioning systems to help solve the cannabis banking problem.

Cannabis Banking Difficulties

Cannabis is a cash-based business, which makes is dangerous and cumbersome for business owners and employees. Legal cannabis businesses find it all but impossible to get bank accounts.

“Because of cannabis’ federally illegal status, the transfer of funds from the sale of cannabis could be considered money laundering. The Bank Secrecy Act, 31 U.S.C. 5311 et seq, requires banks to undertake some due diligence in identifying and reporting potential money laundering activity,” writes Monica Kim, an associate at the Illinois-based law firm of Heyl, Royster, Voelker & Allen, in the National Law Review.

As long as cannabis falls under the Schedule I drug classification, all forms of the plant are illegal under federal law, a reality clarified late last year by the Federal Drug Enforcement Administration. For its part, the Trump Administration’s Justice Department is reviewing existing policy under which the federal government will not interfere state cannabis laws as long as they regulate marijuana appropriately.

The administration’s concern prompted the governors of four states whose voters approved legalized cannabis to send a letter on April 3 to U.S. Attorney General Jeff Sessions and U.S. Secretary of the Treasury Steve Mnuchin. Give pot a chance, the letter essentially asks.

“The Cole Memo and the related Financial Crimes Enforcement Network (FinCEN) guidance provide the foundation for state regulatory systems and are vital to maintaining control over marijuana in our states. Overhauling the Cole Memo is sure to produce unintended and harmful consequences,” the letter states.

The Cole memo and FinCEN guidance provide what little footing banks have in accepting payments from legal cannabis providers. Ms. Kim concludes in her National Law Review article that “banks can serve cannabis businesses in legalized states as long as they follow these strict anti-money laundering procedures including due diligence.”

Opinions are mixed. The California Bankers Association considers cannabis businesses unbankable. Yet several FinTech startup firms are working to make that a reality.

In any case, few banks are buying it, as the State of Illinois itself found when it put out a bid for banks to accept tax payments. Illinois National Bank, Springfield, eventually decided to submit a proposal to collect the 7% tax on medical marijuana and won as the only bidder.

A Cannabis Payment Clearinghouse

This is where the state’s blockchain backing could intersect with its cannabis support. What if the State of Illinois started a bank-like clearinghouse for legal cannabis payments? Here’s how it could work:

Illinois sets up a digital-currency based system, with accounts that customers could use to pay for cannabis using a digital-currency wallet. The state takes in cryptocurrency payments, using something other than bitcoin, whose reputation for drug payments makes it too suspect. Then it pays vendors, employees, owners in USD using existing payment systems, like a bank making foreign-exchange conversions, all for a fee.

The state could work out partnerships with private FinTech startups, which would be necessary to bring digital currency and traditional card payment technologies together. A number of FinTech startups are working on systems to make cannabis payments work with existing systems, and Illinois has a number of blockchain startups with relevant experience.

Industry consultants suggest that partnerships with financial institutions are the way forward for both incumbent businesses and FinTech startups. My own research at FinTech Rising shows that 54% of financial executives responding to a survey on FinTech awareness and partnership already partner with FinTech firms. Some 86% of respondents plan to partner within a year.

Partnership or not, a state-sponsored, crypto-cannabis payment system would be difficult, to say the least. It would require legislative approval, and we know how well that works in Illinois. It could prompt federal challenges to a state government. And people still want to pay with plastic, not digital-currency wallets.

But it would be innovative and certainly result in more interesting stories than the continuing saga of the state’s financial stalemate. Indeed, there’s at least a possibility that it could bring much-needed revenue into a state that has trouble meeting its financial commitments.

Cannabis payments and cryptofinance innovation will not solve the state’s financial problems, to be sure, but the promotion of financial innovation could help attract talent and money to the state’s startup enterprises. Chicago has a long legacy of financial innovation in trading, with the development of financial derivatives and electronic trading exchanges.

Banking laws and drug laws are archaic. Financial technologies and cannabis legalization are heading toward inevitable inflection points. Just as blockchain initiatives are yet another step on the path to digital currencies, medical marijuana is a step on the path to decriminalization and legalization for recreational use, regardless of your opinion on that issue.

The digitization of money is inevitable. The ability of FinTech to empower individuals and community institutions is not, nor is the ability of a state’s voters to set market priorities that conflict with federal rule.

The State of Illinois is on a leadership path in both areas. Let’s find a way to make it pay.

Collin Canright is principal of Canright Communications, a Chicago-based marketing communications firm that specializes in financial services and technology. He also publishes FinTech Rising, a weekly newsletter that provides context and summarizes media coverage of the future of money.